Budget Blues?
The budget delivered on 22 April 2009 by Alistair Darling contained one particularly alarming projection. Government borrowing will rise from the present 39% of GDP to 79% of GDP by 2013-14. It is interesting to note that when Britain had to approach the IMF in 1976 government borrowing was only 50% of GDP. We think a return to the IMF by the British government cannot be ruled out on the basis of the scale of the debt burden. Indeed some government ministers have briefed that going to the IMF should not have a stigma attached to it but instead be “like getting wellbeing care or even like going to a spa to recuperate!”
There can be little doubt that a credible plan for repayment of the debt is crucial in repairing the damage to the UK economy over the next few years if a trip to the IMF “spa” is to be avoided. Also the government has to attempt to show that it can actually repay the debt in order to borrow the money in the first place. So far it has come up with the following:
- Freeze on investment- this in effect means many capital spending programmes will be cut.
- Higher taxes- a decision has been made to raise the top rate of income tax to 50% on earners above £150,000 from 2010. There is also a reduction in pension tax relief for higher earners.
This still leaves a substantial shortfall and more cutbacks in public expenditure or tax rises on middle earners look inevitable shortly after the next general election expected in 2010. Some commentators believe basic rate income tax will rise to 25p in the pound. Cuts are also likely in all areas outside the core services of schools and hospitals- with the axe falling particularly hard on defence, public transport as well as on less well loved projects such as the national ID cards scheme.
However some investors think that the government may seek to inflate away its debt by quantitative easing (printing money) and stoking inflation to erode the real value of the debt. Keeping interest rates low also reduces the burden of repayment (and encourages inflation). This “hidden” third option may be a tempting one for any government as a useful way of avoiding the worst effects of public expenditure cuts. Thus we would warn not to underestimate the possibility of inflation creeping its way back into the system once the world economy begins a recovery. Although the government has charged the Bank of England with keeping inflation at 2%- we have seen how that target has been overshot on a couple of occasions these last few years. Crucially this time the UK government will have a very good reason to want limited inflation back in the system.
We can now see that the highpoint of what can now be seen as a boom was summer 2007- when house prices and asset values peaked. No government wanted the banking crash and most of the funds borrowed by the government have been to enable the banking bailout. But with no plan outlining how the majority of the debt is to be repaid other than the weak measures announced in the budget- the stage is set for a rollercoaster few years for the UK economy.